1 5 Inventory Concepts

INVENTORY IS A LARGE AND COSTLY INVESTMENT

What are Inventories? Finished product held for sale Goods in warehouses Work in process Goods in transit Any owned or financially controlled raw material, work in process, and/or finished good or service held in anticipation of a sale but not yet sold CR (2004) Prentice Hall, Inc.

Where are Inventories? Inventory locations 9-4 Material sources Inbound transportation Production Outbound Finished goods warehousing Customers Inventory locations Shipping Inventories in-process Receiving materials CR (2004) Prentice Hall, Inc. 9-4

Inventory Pipeline 4 Raw & In-Process Finished Goods 1 Vendor In-Transit to Mfr. Plant Whse Mfg. Process Plant. In- Transit to DCs Field Pick & Load Custmr Customer 4 1

Inventory Decisions in Strategy PLANNING ORGANIZING CONTROLLING Transport Strategy • Transport fundamentals Transport decisions Customer service goals The product Logistics service Ord . proc. & info. sys. Inventory Strategy Forecasting Inventory decisions Purchasing and supply scheduling decisions Storage fundamentals Storage decisions Location Strategy Location decisions The network planning process IMPLEMENTING CR (2004) Prentice Hall, Inc.

Inventory Management Objectives Good inventory management is a careful balancing act between stock availability and the cost of holding inventory. , Stock out probability Inventory Holding costs (inventory Carrying Costs) Service objectives Setting stocking levels so that there is only a specified probability of running out of stock Cost objectives Balancing conflicting costs to find the most economical replenishment quantities and timing CR (2004) Prentice Hall, Inc.

MAIN AIMS OF INVENTORY MANAGEMENT To improve cash flows To improve return on investment (ROI, the benefit (return) of an investment is divided by the cost of the investments) ROI= Gains from investment – Cost of investment Cost of Investment $700,000 - $500,000 = 40% $500,000

MEASURES OF INVENTORY MANAGEMENT EFFECTIVENESS The impact that inventory has on corporate profitability Measures to decrease inventory-related costs include; reducing the number of backorders or expedited shipments, purging obsolete or dead stock from the system, or improving the accuracy of forecasts.

MEASURES OF INVENTORY MANAGEMENT EFFECTIVENESS (Cont.) Fill rate is a common measure of the customer service performance of inventory. Product fill rate: fraction of product demand satisfied from product in inventory (single item) computer Order fill rate: percentage of units available when multiproduct order is received. Computer+mouse A 96% fill rate means that 4% of requested units were unavailable when ordered by customer. Cycle service level: if the store doesn’t run out of stock in 6 out of 10 replenishment cycles, the store achieves a CSL of 60 percent

MEASURES OF INVENTORY MANAGEMENT EFFECTIVENESS (Cont.) inventory turnover ratio would be calculated as units sold divided by units on hand.

Inventory Turnover Comparisons

Inventory Management Answers Four Important Questions 4 3 How to order? When to order? What to order? How much to order?

Why Hold Inventory? It enables the firm to achieve economies of scale 4 2 It enables the firm to achieve economies of scale It balances supply and demand It enables specialization in manufacturing It provides protection from uncertainties in demand and order cycle It acts as a buffer between critical interfaces within the channel of distribution

Economies of Scale Inventory is required if an organization is to realize economies of scale in purchasing, transportation, or manufacturing. Per unit price reductions! The cost of maintaining this inventory must be “traded off” against the production savings realized.

Balancing Supply and Demand Seasonal supply or demand may make it necessary for a firm to hold inventory. (finished goods) Demand for a product may be relatively stable throughout the year, but raw materials may be available only at certain times during the year. Ex: Canned fruits and vegetables

Specialization Inventory makes it possible for each of a firm’s plants to specialize in the products that it manufactures. The finished products can be shipped to field warehouses where they are mixed to fill customer orders. Whirlpool Co.- cost savings through specializing manufacturing by plant location and the consolidation of warehouse operations Focused Factories-specialization by facility

Protection From Uncertainties Inventory is held as protection from uncertainties; that is, to prevent a stock out in the case of variability in demand or variability in the replenishment cycle. Inventory planning is critical to successful manufacturing operations to protect from uncertainties.

Inventory As A Buffer Inventory is held throughout the supply chain to act as a buffer for the following critical interfaces: * supplier-procurement * procurement-production * production-marketing * marketing-distribution * distribution-intermediary * intermediary-customer/user

THE LOGISTICS FLOW Finished goods inventory at plant location Raw materials inventory Work-in-process inventory Finished goods inventory at field locations Supplier inventory Consumer inventory Retail inventory Reworking or repackaging of product Forward logistics flow Waste and by-products Waste disposal Reverse logistics flow

TYPES OF INVENTORIES Inventories can be classified based on the reasons for which they are accumulated. In-transit inventories Speculative stock Seasonal stock Dead stock Cycle stock Safety or buffer stock

In-transit Inventories In-transit inventories are items that are en route from one location to another For calculating inventory carrying costs,in-transit inventory should be considered as inventory at the place of shipment origin since the items are not available for use, sale,etc.

Speculative Stock Speculative stock is inventory held for reasons other than satisfying current demand Materials may be purchased in volumes larger than necessary: to receive quantity discounts, because of a forecasted price increase materials shortage, to protect against the possibility of a strike.

Seasonal Stock Seasonal stock is a form of speculative stock that involves the accumulation of inventory before a seasonal period begins This often occurs with agricultural products and seasonal items. Ex: back-to-school

Dead Stock Dead stock refers to items for which no demand has been registered for some specified period of time. Dead stock might be obsolete throughout a company or only at one stock keeping (SKU) location. J.C. Whitney Company-sells auto parts that are no longer produced Transshipment of dead stock-Asia markets

Cycle Stock Cycle stock is inventory that results from replenishment of inventory sold or used in production. It is required in order to meet demand under conditions of certainty; that is, when the firm can predict demand and replenishment times (lead times). Orders are scheduled to arrive just as the last unit is sold-no extra inventory beyond the cycle stock is required.

Cycle Stock Lot or batch size: The quantity that a stage of supply chain either produces or purchases at a given time Q: quantity in a lot or batch size Cycle stock: Q / 2

Safety or Buffer Stock Safety or buffer stock is held in excess of cycle stock because of uncertainty in demand or lead time. Average inventory at a stock keeping location that experiences demand or lead time variability = half the order quantity (cycle stock)+ the safety stock Inventory level time

Factors Influencing Safety Stocks Forecast error Exposure to stockout Lead time Service level requirement 4 14

Under certainty Demand per day:20 units Order quantity: 400 units Lead time: 10 days

The Effect of Reorder Quantity on Average Inventory Investment with Constant Demand and Lead Time 4 Demand:20 units A . O r d e r q u a n t i t y o f 4 u n i t s I n v e n t o r y O r d e r O r d e r a r r i v a l a r r i v a l 4 O r d e r O r d e r p l a c e d p l a c e d A v e r a g e c y c l e i n v e n t o r y 2 D a y s 1 2 3 4 5 6

I n v e t o r y O d p l a c i A g D s 1 2 3 4 5 6 B . q u f The Effect of Reorder Quantity on Average Inventory Investment with Constant Demand and Lead Time 4 5 Demand:20 units

A v e r a g c y l i n t o O d p C . q u f 6 s D 1 2 3 4 5 I The Effect of Reorder Quantity on Average Inventory Investment with Constant Demand and Lead Time 4 6 Demand:20 units

Demand fluctuates between 15 and 25 units per day With variable demand Demand fluctuates between 15 and 25 units per day Lead time is constant

Average Inventory Investment Under Conditions of Uncertainty 11 A . W i t h v a r b l e d m n Average Inventory Investment Under Conditions of Uncertainty I o y g c S s ( f k 5 ) 1 2 8 3 4 D { 4 Demand:2025 units

Variable lead time Lead time fluctuates between 8 and 12 days Demand per day is constant

Average Inventory Investment Under Conditions of Uncertainty 12 Average Inventory Investment Under Conditions of Uncertainty B . W i t h v a r b l e d m I n o y A g c ( 1 4 ) 2 10 { 3 D S s f k 4 If orders arrive 2 days late

With variable demand and lead time Lead time fluctuates between 8 and 12 Demand per day fluctuates between 15 and 25

Average Inventory Investment Under Conditions of Uncertainty . W i t h v a r b l e d m n I o y A g c ( 2 ) 1 10 { 3 4 D S s f k 8 Average Inventory Investment Under Conditions of Uncertainty 4 13

The EOQ Model E O Q = 2 P D C V where: P = The ordering cost (dollars per order) D = Annual demand or usage of the product (number of units) C = Annual inventory carrying cost (as a percentage of product cost or value) V = Average cost or value of one unit of inventory The EOQ Model 4 7

Cost Trade-offs Required to Determine the Most Economic Order Quantity Size of order (Q) Annual cost (dollars) L o w e s t a l c ( E O Q ) Total cost Inventory carrying cost Ordering cost Cost Trade-offs Required to Determine the Most Economic Order Quantity 4 8

Cost Trade-offs Required to Determine the Most Economic Order Quantity 4 9 Order Quantity (Q) Number of Orders (D/Q) Ordering Cost PX (D/Q) Inventory Carrying 1/2 Q X C X V Total 40 60 80 100 120 140 160 200 300 400 48 35 30 24 18 12 $ 4,800 3,200 2,400 1,920 1,600 1,400 1,200 960 720 480 $ 500 750 1,000 1,250 1,500 1,750 2,000 2,500 3,750 5,000 $ 5,300 3,950 3,400 3,170 3,100 3,150 4,460 4,470 5,480 D = 4800 units per year P = $40 per order C = $1 per unit V= $25 per unit

Assumptions of the Simple EOQ Model A continuous, constant, and known rate of demand. A constant and known replenishment cycle or lead time. A constant purchase price that is independent of the order quantity or time. A constant transporation cost that is independent of the order quantity or time. The satisfaction of all demand (no stockouts are permitted). No inventory in transit. Only one item in inventory, or at least no interaction among items. An infinite planning horizon. No limit on capital availability. 10 4

Fixed order point-Fixed order interval policy Fixed order point policy: EOQ-an order is placed when inventory on hand reaches a predetermined min. level necessary to satisfy demand during order cycle Fixed order interval policy: Inventory levels are reviewed at a certain –set time interval like every week